By Kristina Russo | American Express Credit Intel Freelance Contributor
6 Min Read | February 1, 2022 in Money
“Invest early and often.” That was the enduring advice of my college freshman finance professor. Easily said. Easily remembered. But not so easily done.
The first part of the advice, to start investing as early in life as you can, encourages maximizing the combined power of time and compounding. Investing often, the second part, accomplishes two investing goals at once – establishing the routine of regularly putting money away and “dollar-cost-averaging” the price of your investments. But how can you actually implement this advice? Read on for the nuts and bolts of investing and how it works.
Investing is the purchase of financial “instruments” with the goal of growing your money. Growth comes from:
Financial investment instruments – stocks, bonds, mutual funds, exchange-traded funds (ETFs) – all have some level of risk, unlike savings accounts, which are insured by the Federal Deposit Insurance Corporation (FDIC). As you might guess, bigger potential investment rewards come with higher risks. Investments can lose all or part of your money.
Investing timelines tend be long, especially compared to savings timelines. It’s generally accepted that it takes an average of five or more years to weather day-to-day market fluctuations. That timeline may or may not match your financial goals. Sometimes you may have a short-term goal, like purchasing a house or a car. Other times your goals might be longer term, like your child’s education or retirement. For small, even shorter-term goals, when your tolerance for risk is lower and you may want immediate access to your money, savings is a better strategy.
Stocks, bonds, mutual funds, and ETFs are common types of investments.
Mutual funds and ETFs can be made up of equities, bonds, or a mixture of both.
The way you make money by investing depends on the financial instrument.
Stocks, mutual funds, and ETFs: Investment growth usually comes from capital appreciation, which is a technical way of saying that you sell at a higher price than you paid. Their prices are constantly fluctuating, getting many investors excited by market spikes and dips, but it’s important to understand that you do not actually make (or lose) money unless you sell your investment. Until that point, it’s just a “paper gain/loss” or, as the pros would say, an “unrealized gain/loss.” For stocks, mutual funds, and ETFs, there are two main ways you can grow your money:
Bonds: The primary way to grow your money is from the interest payments that the bond issuer (debtor) makes. These payments are usually made every six months. Additionally, the face value of the bond is repaid on its maturity date. Sometimes, you can buy a bond at more or less than its face value, which can create a second source of investment income (or loss). Bond prices may fluctuate from a bond’s face value based on how the bond’s interest rate compares to market interest rates and on the creditworthiness of the bond issuer.
After identifying your investment goal, setting an investment budget, and researching investment options, you may be ready to start investing. How does investing work, mechanically?
You’ll need to open a brokerage account to hold your investments. You’ll buy and sell stocks, mutual funds, bonds, and other types of financial instruments through this account. Brokerage accounts offer various levels of investment help, for a fee:
If your investment goal is for retirement, a tax-advantaged brokerage account may be a good option. These accounts include individual retirement arrangements (IRAs) and 401(k)s through an employer, and they allow your investments to grow tax-free. See “Tips for Retirement Investment Options.”
Regardless of which type of brokerage account you select, none are FDIC insured – even those offered by banks.
If you determine that you’re going to invest in stocks or ETFs, you’ll need to understand how the purchasing works. There are two basic types of purchase orders:
Both types of orders can also be used to sell stocks and ETFs, too. Mutual funds are bought and sold directly with the fund manager, and you typically buy government bonds directly and corporate bonds through brokers.
Unlike savings, where you set aside money that is easily accessed for short-term needs, investing takes a bit more planning and is meant as a long-term endeavor. Identifying your investment goals and selecting investment instruments based on how they can grow your money are the initial steps. Next comes getting to work on the actual investing, by opening a brokerage account, determining what level of advice you’re willing to pay for, and initiating the right market orders. Then it’s up to the markets to work their magic.
The material made available for you on this website, Credit Intel, is for informational purposes only and is not intended to provide legal, tax or financial advice. If you have questions, please consult your own professional legal, tax and financial advisors.